How Startups Can Get an Immediate Cash Benefit from the R&D Tax Credits
February 28, 2017
Allie Colman, an EisnerAmper tax manager discusses changes to the PATH Act that make the R&D tax credit very attractive to start-ups and small businesses. Allie covers the impact on the payroll and AMT taxes, who qualifies, how much the credits are worth and how to apply.
The first key impact is to payroll taxes. Small business that meet specified gross receipts thresholds can now apply a certain amount of its R&D tax credit – up to $250,000 annually – to offset its employer portion of FICA liability immediately, rather than carrying the credit forward to offset potential income tax liability.
Secondly, small businesses that pass certain business structure and gross receipts tests can utilize the credits to offset both the regular and alternative minimum tax.
DP: So, Allie, tell us about what type of tax credits we’re talking about.
AC: We’re going to be talking about the two changes that were made to the R&D credit under the 2015 PATH Act primarily related to payroll taxes and AMT.
DP: In a nutshell, what makes the change to the PATH Act significant? Why is this a big deal for companies?
AC: Startup companies that have losses typically don’t know when they’re going to start making money when they’re going to be paying tax, so they have these R&D credits that are getting carried forward indefinitely for 20 years, and they don’t know when they’re ever going to be able to get a benefit from it. So now this gives those companies that are incurring losses an instant benefit from the R&D credit that we’re calculating, and it saves them cash. So, for companies that are in loss positions, they need to conserve cash where possible, and this is a way for them to do that.
DP: So it’s more of an immediate help.
AC: Right. So R&D credits are normally carried forward for 20 years to offset income tax liability, and there are some companies that have losses for 30 years. So some of those R&D credits may go expired. But we actually are able to now give them instant cash to offset their FICA payroll taxes.
DP: So, yeah, that is a big deal.
AC: Yeah, and it’s also kind of an incentive for them to hire new employees, right?
AC: Because it’s to payroll taxes, so that’s saving them money but they can still get more resources.
DP: Why don’t we start with the payroll tax?
AC: Sure. So, the changes to the R&D credit allow qualified small businesses to apply a certain amount of their R&D credit to offset the FICA portion of employer payroll taxes, rather than carrying the amount forward indefinitely to offset potential income tax liability.
DP: So when you say qualified, what do you mean by qualified?
AC: So, the benefit applies to corporations, partnerships, LLCs or individuals that have gross receipts of less than $5 million in the year of election. However, there is another little nuance that you cannot have any gross receipts for any taxable year proceeding the five-tax-year period ending with the tax year. So, in English, that means that you cannot have any gross receipts prior to the 2012 tax year if you’re making the election for 2016.
DP: And how much is the credit for?
AC: The credit is limited to the lesser of $250,000 or the amount of your R&D credit calculated on your 2016 tax return. Whatever portion of the credit is not used in the current quarter can be used to offset future quarter’s FICA tax liability.
AC: And the credit’s actually available for five years, so it could be a potential tax savings of $1.25 million.
DP: Wow, that’s significant.
DP: And what’s the process for applying for the credit?
AC: Normally, you just compute your R&D credit on the Form 6765 that’s filed with your tax return that’s filed with the IRS. That part doesn’t change, but there is an additional Form, 8974, and that’s where you indicate what portion of your R&D credit you want to use to offset FICA. That is also filed with your income tax return, and then when you file your 941, your payroll tax return, you just attach that 8974 with it every quarter, so they’ll know what portion of your payroll tax you want to offset with your R&D credit.
DP: Now let’s turn our attention to the AMT. What’s the impact there?
AC: So previously the R&D credit couldn’t really be used to offset the alternative minimum tax, or ‘AMT’ as we savvy tax people call it. The PATH act lets certain taxpayers utilize the credit to offset both regular tax and AMT. So prior credits that are generated in 2016 going forward can be used to offset AMT. Unfortunately, this isn’t retrospective, so any of your previous R&D credit carry forwards are still limited to just income tax. So it’s really just a benefit for R&D credits 2016 going forward.
DP: And who’s eligible for the AMT benefit?
AC: So it’s available to small businesses that are private corporations, partnership or sole proprietorships. Then there’s also, similar to the R&D side, there is a gross receipts limitation. So the average annual gross receipts of the entity for the three taxable-year period preceding the taxable year must not exceed $50 million. Again, interpreting that, so for 2016, you would have to look at your 2013, 2014 and 2015 gross receipts, take the average, and if it’s less than $50 million, then you’re good.
DP: Well this sounds like a really good deal for startups and small businesses, so, thanks for this great information.
DP: And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this, and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.